Does the Firm Size Matter? An Empirical Enquiry into the Performance of Indian Manufacturing Firms

The Law of Proportionate Effect depicts that firm’s growth rate is independent of its size; Gibrat (1931). Some of the existing studies support the Gibrat’s Law: Hymer and Pashigian (1962), Mansfield (1962), among others. However, Gale (1972), Shepherd (1972) and recently Punnose (2008) report a positive relationship, while Haines (1970) and Evans (1987) observe an inverse relationship between firm size and profitability. Baumol (1959) opined that rate of return increases with firm size. Therefore, the extant empirical research on the firm size – performance relationship provides inconclusive results. Manufacturing firms’ data from the Steel and Electrical & Electronics (EE) industries are taken from CMIE Prowess database for the period 2004-05 to 2006-07. Results show that firm size affects current profitability: positively in the Steel and negatively in the other. Some more determinants of firm performance are explored. Retained earnings have negative impact on profitability in Steel but, positive in EE. Bank credit is found negatively significant in both the industries. Market share of firms and industry concentration ratio (CR4) although inconsistently are the other significant determinants of firms’ performance. Firms’ market value (Q) is found positively significant for both the industries. This signifies that high market value of firms reflects their goodwill, knowledge stock and prospective investment opportunities which positively influence the firms’ performance. The significance of having high brand equity which the corporate firms thrive for becomes apparent. Interestingly, the impact of size is affected by firms’ market value: firm size positively affects profitability both in Steel and EE. Furthermore, ineffectiveness of Law of Proportionate Effect is strengthened when tested over the combined data of Steel and EE firms. The short-run dynamism in firm performance is also impacted by presence of Tobin’s Q.